Another year has gone bye in the rearview mirror, and we all wish it to stay there. Time to start thinking about 2023. One thing I have learned in 40 years of being in the Investment Industry, is that history rarely repeats itself exactly. However, one must study history to avoid making the same mistakes.
Before we look at 2023 and our thoughts, the chart below is worth looking at. It truly shows how rare 2022 was. The following is a chart from Alpine Macro: titled The Sun Also Rises. On the left we have the returns of the 10-year US Treasury. More than likely in the next 12 – 18 months we will see strong returns from bonds with the understanding the US Fed is efficient in their taming of inflation. On the right we have total returns from the S&P 500, while not the worst year, still bad. We expect much better returns than last year, that is not saying much.
As a gentle reminder last year’s investment results were a result of the US Federal Reserves (FED) in its attempt to slay inflation. So far it is starting to work as we see in the chart below which compares the significant bout of inflation from the 1970’s to today. To me the significant threat to 2023 comes from the FED stopping to soon in the battle against inflation. One of the problems of the 1970’s era battle against inflation was the FED stopping to soon in their endeavors of defeating inflation. Problems they faced included the following:
- Pressure from the sitting President to decrease rates – Nixon – who had appointed Burns.
- Wage and price controls which did not work.
- An oil embargo against the world because of the Arab – Israeli conflict, in which the Arabs tripled the price of oil overnight.
Any of this sound familiar today?
We quite like the chart above as it stands as a template of what to expect in the fight against inflation. The period of the 1970’ was known as the “inflation decade”. What is most important on the chart above is through the year 2024. Quite simply inflation can’t be turned off like one would turn off a fire hose. It will be with us for longer than we want, as we must purge the excesses of the last 20 years!
The Fed made its first decision of 2023 and that was to raise interest rates by 0.25%, a move suggested by the markets the last several weeks. Most importantly, they said they were not done raising rates and and the increases would be smaller and longer to make sure inflation was under control. They do not want to make the same mistakes of the 1970’s. The markets liked this as I feel uncertainty has been removed from the FED.
The chart below is from the Charles Schwab chartbook and shows several sectors that perform well in inflationary times.
Energy, we believe will continue to do well. As you see in the chart below from topdowncharts.com as of 12/31/2022, Energy continues to show capital discipline, and as a result earnings are going up significantly. With strong earnings, more investment funds will flow into the sector resulting in higher prices. Finally, Energy will be one of the sectors that continues to buy back their own shares.
Real Estate and Utilities provide cash flow in the form of dividends and some capital appreciation. We believe in an interest rate environment where the next major move in interest rates to be down, these two sectors will benefit. We still need to watch out for the upcoming smaller FED interest rate increases (in our opinion) before we see capital appreciation.
Industrials will benefit from the supply problems (lower input costs, therefore lower prices) being worked out as covid is fading.
Finally, the U.S. strategic petroleum reserve needs to be refilled, and with China reopening after 3 years of much slower economic activity due to covid, global demand for energy will be increased.
In looking at the chart above, consumer confidence is everything. The key to reading this chart is looking at the numbers on the peaks and valleys, as they represent the return the following 12 months.
My favorite chart of the last two years. Quite simply shows the end of a 40 year bull market in bonds. In addition it show the equity returns in a rising interest rate environment, and a declining interest rate environment. What will we happen next with interest rates? The whole world hopes we go sideways at worst to declining slightly. I doubt we will ever see zero interest rates again. If we do, not a good situation!
As always we live in interesting times, and it is a joy for us to try and understand what is happening here in the US and around the world as it affects investments.
If there are ever any topics you wish for us to explore, please let us know. We are here to help and guide you through these times.
We thank you all for taking the time and reading “Market Watch.” It is meant as an educational piece on the always evolving markets. It is something we plan on providing every month, and your feedback is very important to us.
On a personal note, RMH is now in the position to bring on new clients so please be sure to share this informational letter with whomever you wish. RMH’s focus is on the customizable investment needs of individuals, families, and foundations. We enjoy working with our clients to better understand their goals, values, and passions for what is important in their lives. In expanding our client base, we look forward to working with people who share these same desires.
Richard Mundinger, CFA
Ashlyn Brooke Tucker
Sources:
Alpine Group – Global Strategy – “The Sun Also Rises”, October 31, 2022
AGF 2023 Outlook
JP Morgan: Guide to the Markets, as of December 31, 2022